Like-kind exchanges and QIs.

• Author: Wise, Dan
• Position: Qualified intermediaries

The premise is simple: a taxpayer exchanges a property for one that is similar and defers the tax consequences.

Example 1: At arm's length, A exchanges property X, with a $10 fair market value (FMV) and a $5 adjusted basis, with B for property Y, with a $10 FMV and a $9 adjusted basis. Without Sec. 1031, A has a $5 taxable gain and a $10 basis in the new property. However, under Sec. 1031(a), A has a $5 deferred gain and a $5 carryover basis in Y. (Note: the relative values of the two properties is irrelevant; even if X's value is appraised at $20, the result is the same.)

Congress's intent (back in 1924) with the like-kind exchange rules was to refrain from imposing tax when no cash would result from a transaction that seemed to have no real consequence. Thus, Sec. 1031(b) provides that the receipt of other property in a like-kind transaction will trigger gain recognition up to the FMV of such property received ("boot").

Example 2: The facts are the same as in Example 1, except that X's FMV is $20 and B pays A $10 for the difference in property values. The $5 deferred gain and $5 basis still result; additionally, A recognizes a $10 gain (total realized gain is $15), equal to the cash received.

Congress did not originally anticipate that an exchange might not be simultaneous. Further, "like-kind" in the real estate context has been defined broadly; today, any two pieces of real estate held for investment or business use (but not inventory) are like-kind, which has generated a cottage industry of qualified intermediaries (QIs). The QI-involved transaction is the most common form of modern Sec. 1031 real estate exchanges. Essentially a three- or four-party transaction (including the QI), such an exchange is quite different from the two-party type contemplated by the 1924 law, which raises some problems. The following discussion addresses some issues this causes in practice.

Form HUD-1

Real estate transactions are recorded on a settlement sheet (Form HUD-1, Settlement Statement), as required by Federal law. This form is used to report an exchange accurately and reflects the financial settling-up of the parties. The two transacting parties--the ones involved in the transfer of legal title to the real property--are referred to on Form HUD-1 as the "seller" and the "borrower." The question in the case of a four-party like-kind exchange is: Who should be listed as the party opposite the third party on the HUD form--the taxpayer or the QI?

Although...